Domination Isn't (Always) Fraud: Venezuela Edition

posted by Mark Weidemaier

I made a joke in the comments to Mitu’s post about whether the arrest of Citgo executives strengthened the argument for treating Citgo as Venezuela’s alter ego. The joke wasn’t very good; I called Venezuela a “typical activist shareholder.” But Mitu generously took it seriously, asking whether this is the kind of behavior creditors should have expected. His question highlights some interesting legal questions. One is whether a creditor who knows about shareholder misconduct before voluntarily dealing with a corporation should be able to enforce its claims against shareholder assets. A second has to do with the legal standard for finding a corporation and its shareholder to be alter egos.

Creditors have long had reason to know that Venezuela wields extensive control over PDVSA and, at least potentially, over entities like Citgo lower in the corporate chain. Mitu's response to my comment asks, in effect, whether a person with such knowledge who voluntarily becomes a creditor (here, of Venezuela) should be barred from seeking to pin liability on other entities. Legally, I think the answer is “no.” The law in this context clearly identifies shareholder control as a sufficient basis for a finding of alter ego liability, at least when the shareholder "dominates" the corporation. Why should the result change when a creditor knows of the control in advance?

Think of this in the usual context involving voluntary creditors of a corporation. Because of limited liability, these creditors generally can’t look to the shareholder to satisfy corporate debts; if they want that protection, they should negotiate with the shareholder for a guarantee. But the result changes if the shareholder uses its control over the corporation to elevate itself in priority over corporate creditors (as by stripping the corporation of assets). Mitu’s question posits a third case, in which a prospective creditor of the corporation knows the shareholder has a penchant for such shenanigans but chooses to become a creditor anyway. In such a case, picking a legal rule requires a choice: Should the law (A) force the creditor to negotiate for the shareholder’s guarantee, or (B) maintain the usual rule in which the creditor can pursue the shareholder without an express guarantee? I can’t think of a case that answers this question, but I don’t really see the argument for option (A). Why should a creditor with knowledge have to contract into the rule that the law would otherwise (in a case with an ignorant creditor) supply by default? I suppose we could infer from the creditor’s knowledge of the shareholder’s tendencies that it was content to limit its recourse to the corporation and its assets, but that seems an implausible inference. Moreover, why complicate the already-complicated alter ego analysis by adding an inquiry into what a given creditor happened to know about the shareholder's propensity for bad behavior?

An even more interesting question is whether it makes sense to treat a corporation and its shareholder as alter egos merely because the shareholder dominates the corporation. At least in the context of corporations owned by foreign sovereigns, it is quite clear that a sovereign can be liable for corporate debts (and vice versa) purely based on a finding of extensive control. Yet the cases—sensibly, in my view—tend to premise alter ego liability on some type of fraud (as in my asset stripping example above). Here’s where Venezuela has made things interesting. Arresting corporate management, especially on grounds that seem clearly pretextual, strikes me as pretty good evidence of domination (in this case, of a remote subsidiary). Yet as I’ve said here before, without evidence that the control has been used to a creditor’s disadvantage, it’s hard to see why anyone should care. After all, presumably governments choose to pursue policy objectives through state-owned entities precisely because they want to exercise more control than is possible through regulation alone. So it's hardly surprising to find significant involvement by government officials in corporate affairs. Admittedly, the involvement here is a bit more ... colorful than the norm. Yet when courts refuse to recognize the corporate form they impose real costs—not just on the foreign government, but potentially on US corporations acting abroad, which may face retaliation. If the foreign government has used its power as shareholder to harm creditors, those costs are worth bearing. Indeed, as I implied in the post linked above, disregarding the corporate form in such cases will often further the goals underlying the Foreign Sovereign Immunities Act. But the answer is less obvious in cases where alter ego liability is premised purely on control.

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